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A Tale of Two Tapers

The US Federal Reserve and the People’s Bank of China are not typically seen as two peas in a pod. But they have had similar experiences in recent weeks – and neither has been a pleasant one.

CAMBRIDGE – The United States Federal Reserve and the People’s Bank of China are not typically seen as two peas in a pod. But they have had similar experiences in recent weeks – and neither has been a pleasant one.

The Fed’s bout of indigestion started with Chairman Ben Bernanke’s June 19 press conference, where he warned that the Fed’s purchases of long-term securities might start to taper off if the economy continued to perform well – specifically, if unemployment fell to 7%. Stock prices swooned. Yields on US Treasuries spiked. Emerging-market currencies weakened on fears that capital flows from the US would reverse direction.

Indeed, the reaction was so extreme and alarming that a parade of Fed officials felt compelled to clarify. To say that the Fed’s policy of “quantitative easing” might taper off, they explained, was different from saying that it would be halted. When and how purchases of long-term securities were reduced would depend on incoming data. In particular, there was no guarantee that 7% unemployment would be reached before the end of the year.

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Professor Eichengreen calls attention to interest rates and central bank funding. These are not as fundamental as productivity, consumption, sustainability, employment and equality/distribution to an economy.

Our modes of consumption and distribution have not kept pace with our modes of distribution and productivity over time. Unless we adjust soon, our new world of higher interest rates soon may plunge the developed world into the crisis of democracy happening in the population boom world as seen in the Arab stirrings now.

The problem with the zero lower bound is that Fed can only make 'guidance' statements as it has no other instrument on hand. The question is any which way we see the Fed has to either say the economy is doing better or doing worse. In this case it settled for the former and the markets reacted the other way. Are we suggesting that Fed now should take a U turn? On the other hand making no statements is also not taken kindly by the market.

The fact of the matter is that playing to the whims and fancies of the market cannot be the role of the Fed; by the gyrations that ensue each FOMC meeting we are repudiating the role of Fed to be the trustee of what happens well with the money it eases.